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BHEL: Strong show
Jan 27, 2007

Performance Summary
Public sector power generation equipment major, BHEL, has announced yet another quarter of strong performance, wherein it has reported 32% YoY topline growth during 3QFY07. Moreover, on the back of improvement in operating margins, net profits have surged by 58% YoY. Lower staff costs, combined with stock related adjustments, have been the main factors for expansion in operating margins. The board of the company has recommended an interim dividend of Rs 12.5 per share (dividend yield of 0.5%) and a bonus issue in the ratio of 1:1 (one additional share for every one equity share held by members on the record date to be fixed soon).

Financial performance: A snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Sales 32,944 43,397 31.7% 77,093 103,178 33.8%
Expenditure 26,915 34,105 26.7% 65,660 86,141 31.2%
Operating profit (EBDITA) 6,029 9,292 54.1% 11,433 17,037 49.0%
Operating profit margin (%) 18.3% 21.4%   14.8% 16.5%  
Other income 1,187 1,855 56.3% 3,175 4,755 49.8%
Interest 136 120 -11.8% 392 387 -1.3%
Depreciation 620 662 6.8% 1,819 1,967 8.1%
Profit before tax 6,460 10,365 60.4% 12,397 19,438 56.8%
Tax 2,228 3,688 65.5% 4,285 6,795 58.6%
Profit after tax/(loss) 4,232 6,677 57.8% 8,112 12,643 55.9%
Net profit margin (%) 12.8% 15.4%   10.5% 12.3%  
No. of shares       244.7 244.7  
Diluted earnings per share (Rs)*         87.1  
P/E ratio (x)*         28.1  
* On a trailing 12-month basis

What is the company’s business?
Bharat Heavy Electricals Limited (BHEL) is India's largest public sector engineering company with market leadership in supply of equipments to the energy-related/infrastructure sectors. The company has installed equipments for over 90,000 MW of power generation in the country, which includes capacities set up by utilities, captive and industrial users. Revenues from the power sector form around 73% of the company's total revenues, with the remaining being contributed by the industrial segment. The company has strong ties with the power generation major, NTPC, and historically, has bagged over 70% of the contracts floated by the former. During the period between FY01 and FY06, BHEL’s sales and net profits grew at compounded rates of 19% and 40% respectively.

What has driven performance in 3QFY07?
‘Power’ful drive to topline: BHEL’s power segment (73% of 9mFY07 total sales) led the strong 32% YoY growth recorded by the company for its topline during 3QFY07. The segment’s growth was powered by strong order intake combined with execution to the already bulging backlog. Among major contracts in this division, the company bagged Rs 3.8 bn contract from Punjab State Electricity Board fro renovation and modernisation of 2 thermal generating units in Punjab.

Segment-wise performance…
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Power
Revenue 27,518 35,387 28.6% 64,685 84,355 30.4%
% share 74.2% 73.5%   73.7% 73.2%  
PBIT margin 23.0% 23.9%   19.6% 21.7%  
Industry
Revenue 9,568 12,741 33.2% 23,056 30,846 33.8%
% share 25.8% 26.5%   26.3% 26.8%  
PBIT margin 14.2% 12.3%   12.8% 10.4%  
Gross Total*
Revenue 37,086 48,128 29.8% 87,741 115,201 31.3%
PBIT margin 20.7% 20.8%   17.8% 18.7%  
* Excluding inter-segment adjustments

Apart from the abovementioned contracts in the power segment, the company has also bagged Rs 9.5 bn order from Bharat Oman refinery Limited, for setting up a 99 MW captive power plant in Madhya Pradesh (this order forms part of the Industry segment of BHEL). Importantly, this is the highest-value single order for a captive plant for BHEL and indicates the growing clout of the company amidst increasing competition in the Industry segment from other domestic and MNC generation equipment makers.

At the end of December 2006, the company’s order backlog stood at Rs 467 bn, which is over three times the company total sales in FY06, and 38% higher than the backlog at the end of December 2005. As we have indicated in the past, the company is in the process of expanding its annual capacity from 7,700 MW currently to 10,000 MW in line with the huge anticipated demand for setting up generation capacities in the tenth (2002-07) and eleventh (2007-12) five-year plans.

Lower staff costs aid margins: Decline in the number of employees on its payroll as part of the manpower restructuring scheme, continues to benefit BHEL in terms of lowering its staff cost (as percentage of sales). This was witnessed in 3QFY07 as well, wherein staff costs declined to 11.8% of sales, from 13.7% in 3QFY06. Benefits on the stock adjustment front also aided the company’s operating margins during the quarter. Based on segments, while PBIT margins for the power division expanded from 23% in 3QFY06 to nearly 24% in 3QFY07, those for the industry segment contracted by 190 basis points (1.9%) to 12.3%. While we have estimated BHEL to earn operating margins of 16.4% in FY07 (16.2% in FY06), we shall have to upgrade the same considering the strong profitability performance in the nine-month period of this fiscal.

Higher other income, lower interest aids bottomline: Apart from the expansion in contraction in operating margins, BHEL’s net profits also benefited from higher other income and lower interest outgo during 3QFY07. Consequently, net margins improved by 260 basis points (2.6%) to 15.4% during 3QFY07.

What to expect?
At Rs 2,448, the stock is trading at a multiple of 14.1 times our estimated FY09 earnings. While the company, as a consortium partner with NTPC for the ultra mega power projects has not been successful in the first two such projects that were announced recently, it already has its hands full in having a large backlog to execute over the next 24 to 36 months. Considering its 9mFY07 performance, we shall have to revise upwards our estimates for the company.

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